The hedge fund industry has a 'real problem', and it's not the one you think

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RealVisionTV

Rory Hills.

The hedge fund industry is struggling.

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Poor performance, insider trading investigations, and the winding down of some marquee funds have marred the industry as of late and dominated headlines.

There is another problem, too, and it is one fewer people are talking about.

All the money is going to a handful of funds, it is harder than ever to set up a new fund, and there is less diversity in the industry as a result.

Rory Hills, founder and Partner of fund of hedge funds Hilltop Fund Management, touched on this in an interview with Raoul Pal of Real Vision TV.

Here's the relevant passage from the transcript:

Raoul Pal: One of the things I notice ... is that new managers, people who have a specific expertise, they can't raise any money, and so they die off not because they aren't very good at what they do, it is because they have to last five or six years to build a track record running $10 million, and they can't pay their bills. It is almost impossible to survive unless you come from pedigree, or you knock the ball out of the park immediately, and maybe do it two years in a row.

Rory Hills: It is a real problem, a real problem for the industry. What we need is more platforms, the old school kind that existed before the crisis but don't exist so much anymore. Cheyne is still going. That type of platform I think we need more of. More people who have the apparatus, particularly in this increasingly regulated world, it is so expensive for people to set up a new fund. I htink there is a real role for new platforms, who have all the reglatory stuff, all the compliance, all the infrastructure, all of that set up so people can come in and switch on a Bloomberg. That has to be combined with a different seeding level.

There are a couple of reasons why this is happening. Investors tend to be more comfortable investing in vanilla funds which have already reached a certain size. Hills said this was partly a result of funds of funds, which invest in a variety of hedge funds, putting manager selection in the hands of junior analysts.

Raoul Pal

Real Vision Television

Raoul Pal.

"I really believe that's the center of the problem," he said. " Junior analysts gravitate towards plain vanilla type strategies, relatively easy to understand, easy therefore to explain to investment committees. Sometimes these smaller, more niche managers are more complicated and not as easy to understand."

Now, Hills has a reason to make this argument. He himself runs a funds of funds which avoids the big names and looks to put money in the other 90% of funds that don't get as much attention.

Still, the shift he is describing has long-term implications for the industry. Ral and Hills share the fear that the industry will "die" as people continue to allocate to the big managers and new managers with specific expertise can't survive.

"One household name over here," said Hills, "is of the view it will just go back to the way it was 30 years ago, 100 hedge funds with mostly high-net-worth type individuals as investors."